Why do we feel that poor people need financial education?

I am not at all sure I could live on a few dollars a day. Why would I think that those who do need financial education? Yet in any meeting or conference on financial inclusion, someone will clamor for financially educating the poor and all will readily nod. Please allow me to side-step the substance of the issue, for I have no new empirical evidence to bring to the table either way. What I find curious is why the idea that poor people are lacking essential financial literacy skills is so prevalent among the non-poor. Let me propose five reasons.

1. The poor mis-spend

Who hasn’t wondered why it is you can find Coke bottles in the poorest communities in developing countries? Who hasn’t had a pang of doubt upon seeing reams of shiny bags of candy hanging from the shabbiest stalls in the remotest villages? And you’re thinking: my parents didn’t buy me this stuff! Well, it might be because your parents had plenty of other ways to reward you and each other. Think toys, ski trips, family outing to a restaurant, gifts, etc. Next to these things, splurging one day on some candy and a Coke seems downright meaningless. But for many it might be the easiest way to create magical family moments, to transcend a dreary daily routine. If it helps keep the family going and united, it might be a bargain. We musn’t pass judgment on how the poor spend their money, for we cannot imagine the job that they are ‘hiring’ those seemingly superfluous products to fulfill.

2. The poor will waste it away
A more extreme version of the mis-spending argument revolves around the drinking or other deleterious habits often observed in the field. I cannot imagine that such behavior could be cured by demonstrating the negative ROI on drinking. No amount of financial education will change this state of affairs, solutions must lie elsewhere.

3.The poor are making some clearly sub-optimal financial choices
A third reason why financial education may seem so alluring as a policy prescription may have to do with our perceptions of how poor people make investment rather than spending decisions. For instance, many poor people like investing what little they amass into buying a couple of cows, and yet learned researchers might show that those cows have a low, or even negative, ROI. Again, are we sure that we are evaluating such decisions against the right objectives? The poor person may not be thinking total returns and may not even view the cow as an investment asset. Rather, it’s a way of making a little bit of steady income appear every day, in a world where all other household cash flows are uncertain: an insurance.
By the way, your insurance policies also likely have a negative expected value or ROI. That pays for all the moral hazard, adverse selection and admin and marketing costs embedded in the pricing. But that buys you peace of mind, so you are ok with it.

4. The poor will over-borrow
A product-specific argument for financial education is that people can harm themselves with too much credit. They might, but then again so might almost everyone else. Cycles of debt exuberance seem to be a fact of life, but they often ride broader socio-economic trends rather than individual ignorance (viz. global financial crisis). The poor are hardly uninitiated as regards debt, as they have lived for centuries borrowing from friends and neighbors and stores and money-lenders. It is true that modern finance may offer them more and easier credit options (such as the credit card) than they’ve ever had before, so we do need to put in place adequate consumer protection mechanisms that prevent lenders from placing credit irresponsibly with over-indebted households. Consumer education is a component of that, but that alone cannot tame the kinds of credit cycles that we have seen over and over again.

5. The poor don’t know how to use formal financial products
A final general argument for financial education stems from how they interact with formal financial products. Let’s assume, in Portfolios of the Poor fashion, that poor people are actually quite savvy in using the informal financial options that are available to them. Still, these options are often not very good, and we need to expose them to formal financial options. Yet when they are given modern electronic accounts, even if complemented with convenient access points nearby, we often observe that they don’t use them much, if at all.

The basic fact we need to face up to is that when people receive an electronic payment into their (bank or mobile money) account, the universal tendency is to withdraw the money immediately and in full, beating a hasty retreat back into cash and the informal. Why can’t they see that it’s better to just keep the money in the account until they need it? It’s indeed tempting to believe that financial education is about giving them the knowledge and tools to be able to take advantage of a new range of superior products which they are unfamiliar with.

It may be that such financial education remains necessary, but I cannot view this as anything other than a product design failure. People will need to be educated only if: (i) those products are too complex to understand or handle, or (ii) effective use of those products requires changing people’s money management mental models and practices rather substantially. Surely you’ve had the experience of an amazing new business productivity tool being introduced at your workplace – except that few people bothered to learn how to use it and it required changing all business processes to accommodate it. Did you blame yourself for not using it?
It may be that we never will be clever enough to make formal financial products intuitive enough and so naturally fitting into poor people’s mental models and money management practices. But then it would be more honest to talk about proper product marketing.

So why the fuss?

All of the above intuitive arguments for financial education have a strong paternalistic ting. I find it disconcerting that, in the twenty-first century, they are so seductive to so many people. Particularly because there is little empirical evidence demonstrating any sustained benefit from adult financial education programs. And that’s not for lack of trying or funding: part of its appeal in the donor world stems from how easy it is to set up programs and conduct randomized control trials around it.
There may still be a logic for financial education, but we need to be more specific about the evidence and the hypotheses that justify such interventions. For example, I am ready to believe that it has a place in school curriculums. Only then can we design more effective mechanisms to deliver it.

Comments

I agree with all five of your points. There is one other argument that I think you are missing: the damage done by sub-optimal financial decisions is obviously greater to the poor than to others. I know that I make many of the errors that financial literacy is designed to combat, but I have enough of a margin that which savings account I use (or at today's historically low interest rates/inflation) or whether I use a savings account or cash doesn't matter. Therefore, there is a strong argument that I need financial education less.

For people who are struggling to make ends meet, pennies and dollars lost or gained matter much more of course.

That, though, leads us back to the core problem: we have not idea how to deliver financial education to anyone, rich or poor, that consistently changes financial behaviors.

You are partly right. Everyone needs financial education including the poor. Cooperation learnt from financial education can encourage the poor to form cooperatives and enhance the financial conditions through teamwork.

If poor people were found to be making sub-optimal choices when they buy food (which of course most would, on a pure calories-per-dollar basis), would we then put them on nutritional education programs? That would likely save them a lot more of those pennies and dollars.

Tim, I am not sure I agree with your diagnosis of the "core problem." If we found an excellent way of "delivering" financial education, are you so sure that you'd know what you'd want to teach them?

Agree with all five points. When I hear talk of the importance of financial education (usually in the context of not overborrowing), I find it is but a way of deflecting blame from those doing the overlending. And that brings to mind a sixth point that I think you have missed -- messaging.

Lending is a profitable enterprise, and advertising messages reminding consumers (especially poor ones) of their many options to borrow are ever-present. Moreover, I'm quite convinced that those messages are effective not only in helping consumers choose between one or another lender, but in getting people to borrow more overall.

But what about messages that counteract the constant reminder to borrow, borrow, borrow? They're far less prevalent, especially when targeted to the poor. That's because for financial institutions, the business case for gathering small deposits is far less compelling than making small loans, and when it is pursued, it largely rests on cross-selling, i.e. marketing loans. At the end of the day, financial institutions will always find making small loans more profitable than collecting small deposits, and that's the balance that's reflected in their advertising.

To me, the financial education that matters cannot get delivered in classroom exercises. It has to be in the form of steady, ongoing campaigns that remind people to save, thus balancing out the incessant message telling them to borrow. Ultimately, that means looking closely at the financial sector, and finding ways to make lending less profitable, and deposits -- more so.